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Positive climate helps attract more FDIs

— PHOTO: AFP

OPENING THE FLOODGATES: The courtyard in New Delhi from where judicial clerks, notaries and advocates prepare documents for foreign clients. Over the last decade, liberalisation has improved the climate for investment in India.

The inflow of foreign direct investments (FDIs) into India has shown a significant increase and even overtaken the inflow by way of foreign institutional investments (FII) during the last financial year.

However, FDIs still remain at a low ebb when compared with its neighbour China, which is one of the largest emerging economies in the world today. The growth registered in FDIs is by no means enough and major administrative and legislative initiatives, including political consensus, would be necessary for India to achieve a great leap forward.

FDIs into India increased sharply from $7 billion during 2005-06 to $19.5 billion during 2006-07, on the strength of expansion in domestic activity.

According to the Reserve Bank of India (RBI), “positive climate, progressive liberalisation of the FDI policy regime and simplification of procedures,” are the factors which helped India attract these FDIs. The accelerated pace of mergers and acquisitions in sectors such as financial services, manufacturing, banking services, information technology and construction are also thought to have boosted FDI inflows.

When the FDI inflow stood at $19.5 billion last fiscal, portfolio investment was pegged at $7 billion.

The jump was quite significant compared with earlier figures: In 2003-04, the FDI was $4 billion and portfolio investment $11billion; in 2004-05, the FDI was $6 billion and portfolio investment $9 billion; and in 2005-06, the FDI was $7 billion while portfolio investment was $12 billion.

Among the newly resurgent economies, India has now emerged as the second most preferred FDI destination after China. India’s share in global FDI flows increased from 2.3 per cent in 2005 to 4.5 per cent in 2006. Country-wise, Mauritius and the U.K. are the major FDI investors in India. Large flows from Mauritius could be attributed to its use by investors from other countries for channelling FDI flows into India. FDI flows from the U.S., the Netherlands and Singapore also increased sharply during 2006-07.

Sector-wise, manufacturing industries and services, particularly finance and business services, have remained the major beneficiaries of FDI inflows. The services sector attracted the maximum FDI ($6.1 billion in 2006-07 against $1.4 billion in 2005-06). FDI inflows into the construction sector financing, real estate and business services also increased substantially during 2006-07.

Overseas direct investment from India also exhibited a significant rise during the year — from $4.5 billion during 2005-06 to $11 billion during 2006-07, reflecting large overseas acquisition deals by Indian corporates to gain market shares and reap economies of scale, amidst the progressive liberalisation of the external payment regime.

Both FDI inflows and outflows during 2006-07 included one transaction amounting to $3.1 billion, involving a swap of shares. Even the net value of these transactions (FDI inflows and outflows at $16.4 billion and $7.9 billion, respectively, during 2006-07) is significantly higher than those in the previous years. Overseas investment, which started off initially with the acquisition of foreign companies in the IT and related services sector, has now spread to other areas such as non-financial services.

However, the latest figures (for the first quarter of the current fiscal) released by the RBI last Friday show that portfolio investments are higher than the FDI inflow. Direct investment showed strong bi-directional movement, reflecting higher FDI into India as well as overseas investments by the Indian companies.

The inflows under FDI were $5.9 billion against $2.5 billion in first quarter of 2006-07. FDI was channelled mainly into the services sector (37.3 per cent) followed by construction industry (21.9 per cent).

Outward FDI also showed significant increase at $5.4 billion during the quarter under review ($1.1 billion). This shows, RBI states, “the appetite of Indian companies for global expansion”.

Due to large outward FDI, the net FDI (FDI into India minus FDI by India) was lower at $0.5 billion in the first quarter of 2007-08 than $1.4 billion in the first quarter of 2006-07. Meanwhile, net inflows by FIIs were $7.1 billion.

“The real significance of FDI is not just the small net FDI inflow. The real value to India is from the full two-way flow,” said Ajay Shah, Senior Fellow, National Institute of Public Finance and Policy. The growth of FDI inflow and outflow is part of the country’s integration to the world economy. “While inflow is increasing, outflow is also equally exciting as Indian companies are also becoming multinationals by building and acquiring companies abroad,” said Mr. Shah. With the RBI easing the outbound investment norms last Tuesday, outflows would be accelerated further.

“The general pattern reflects that there are a lot of companies emerging in new sectors and those companies are not listed,” said Subir Gokarn, Chief Economist, Standard & Poor’s (S&P), Asia-Pacific. The FDI inflow mostly reflects strategic investments as private equity, which certainly ensures the long-term bullishness of the economy, he said.

China’s FDI is higher than India’s. China received around 25 per cent of all FDI from developing countries over the past decade, according to a recent World Bank report. It also stated that from 2006 to 2010, China is expected to account for about 30 per cent of the projected $250 billion of FDI inflow from developing countries.

The report further stated that most of the foreign capital has entered the industrial and manufacturing sectors, rather than services or agriculture, that are more crucial for the nation’s economic restructuring. During the XI Plan (2006-10), China is likely to focus on more balanced development and more attention will be paid to domestic development, regional balance and reduction in energy and resource use. The report also warned China that the rise of India, Brazil, Thailand and Mexico as major FDI destinations would divert China’s FDI inflows. The World Bank also told China to use FDI to achieve harmonious society goals.

Now the question is: Do we want to support the local companies or not? If India wants to support the growth of local companies, then the government has to give them access to world-class finance. “Let them get cheapest equity capital, cheapest debt capital and risk management. All this means integration with global finance and capital account convertibility. “China has done much more than India in achieving capital account convertibility. Foreign companies have access to these funds and it is a non-level playing field for Indian companies,” says Mr. Shah.

“We are still having so many restrictions. India needs more FDI and India needs more foreign participation in Indian banking. China started its liberalisation in 1978 and we started in 1991 and China is far ahead of India,” Mr. Shah added.

While FDI is overtaking FII investments in the country, RBI’s views from its latest annual report are of great relevance: “It is useful to narrate some noteworthy features of capital inflows into India. FDI is generally perceived to be an investment that creates physical assets and is associated with a degree of stability, in particular, due to managerial skills. However, new types of FDI flows through private equity funds and venture capital funds may not necessarily have a direct link with investments in physical assets and could contain a volatile component at the margin.

Similarly, inflows to acquire existing stakes or expanding foreign stake in Indian companies are classified as FDI, but they do not contribute to the further creation of physical assets. However, these inflows do add to the foreign resources available for investment in the economy, which would be most productive when there is corresponding absorptive capacity at macro level.

The FIIs, in their own account, are generally long-term investors with little or no interest in managerial control. However, investments under the FII category in India have a significant part of portfolio flows through Participatory Notes and sub-accounts. Capital flows particularly, the portfolio flows, being volatile, can easily reverse their direction and it is difficult to invoke the ‘rules of origin’ with regard to such capital flows.”

Against this backdrop, the Reserve Bank states that the gradual process of fuller capital account liberalisation will be pursued over the medium-term, while recognising the growing ineffectiveness of macro controls in a world of growing trade and financial integration.

Thus, in India, the trade, financial and capital account liberalisation do go together, but in a harmonious and well sequenced manner, while closely aligning with the progress in the real sector, fiscal sector and institutional developments including governance.

OOMMEN A. NINAN

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